“Options offer an insurance against adverse price movement.”

The Multi-Commodity Exchange of India Ltd (MCX) has been playing a significant role in enabling hedging of commodity price risk and portfolio diversification. In an interview with Niladri S Nath, Shivanshu Mehta, Head, Bullion, MCX, talks about the journey of MCX so far and their latest offering, Options, new derivatives instruments.

The Retail Jeweller (TRJ): How has the role of MCX evolved in the commodity derivates and futures?
Shivanshu Mehta (SM): MCX has evolved as the largest commodity exchange in India. MCX started its operations on 10th November 2003 and today it holds a market share of over89.73% (9M FY17-18)of Indian commodity markets.

MCX has played a major role in strengthening of the financial markets by enabling hedging of commodity price risk and portfolio diversification through investment in commodities. It has integrated rural, urban and global markets, facilitated efficient price discovery, increased awareness about quality standards, instilled price transparency besides providing convenience and assurance of delivery.

Over the years, MCX price in many commodities has emerged as the benchmark for participants across the value-chain of those commodities. For instance, pricing in gold and jewellery markets are done on MCX (+/-) basis in several locations, that is, using MCX gold prices as the acknowledged reference price. Participants across the bullion value chain also find MCX a preferred platform for hedging their risks arising from volatility in bullion prices.

One of the most significant recent development has, of course, been the introduction of options. By becoming India’s first commodity exchange to offer commodity options, MCX has been a pioneer in reaching out to the small hedgers and investors.

TRJ: How have been the Gold Derivatives at MCX helping jewellers in their retail trade?
SM:As MCX gold prices reflect the international gold price, USD-INR rate, import duty changes, and prevailing premium/discount, MCX prices are a natural hedge against these movements. This enables all major value-chain participants such as importers, exporters, nominated agencies, bullion traders and branded and retail jewellers to hedge their price risk efficiently. MCX gold prices have a strong correlation with international benchmarks (e.g. 98.93% with the INR equivalent import parity price of CME gold) as well as with domestic physical market (e.g. 98.02% with Ahmedabad market spot prices).

Thus, physical participants, such as jewellers, are able to lock in their input prices or hedge their inventories using MCX gold derivatives. For instance, when a jeweller buys gold at a fixed price, he faces the risk of price fall by the time he sells the jewellery, to hedge against which he could sell MCX Gold futures, thereby creating an offset hedge.
As for sourcing of raw materials, the delivery mechanism at MCX ensures the quality and quantity of supply of the commodity to all stakeholders. More than 100 tonnes of Gold andover 2808 tonnes of silver have been delivered using the MCX platform so far, demonstrating the acceptance of MCX platform by physical market stakeholders.

TRJ: What are the prevailing market scenario and insights that prompted MCX to launch gold options?
SM:India’s jewellery industry is at a transformational stage. Traditional and largely unorganised jewellery businesses are slowly making way for corporate players. Policy reforms such as demonetisation and GST and related compliances have only accentuated this shift. Smaller jewellers are feeling most threatened with the transformation as they are devoid of better margins and connectivity to the larger world of financing.

At the same time, jewellers are also feeling the heat of large volatility in gold prices. During FY 2016-17, annualised price volatility in gold had been over 13%. This means that a jewellery firm with a gold stock of Rs.100 crore is exposed to a price risk of Rs.13 crore, enough to put its business planning process in jeopardy. While small jewellers look towards various effective hedging options available, some big jewellers take to metal loans to hedge the risks arising from gold price uncertainty, but only with partial effect.

It is in this market scenario that MCX decided to offer a product that would meet the risk management needs of even the small jeweller, beyond what was available to them by way of the multiple-sized gold futures contracts. As the regulator had permitted exchanges to apply for commodity options in 2017, MCX decided to take the opportunity and launch gold options.

TRJ: What are the strategic benefits the Gold Options will offer to the jewellers?
SM:Options provide tangible strategic benefits to jewellers, which many other types of risk management instruments are not able to. They offer the buyer an insurance against adverse price movement, but allow for gains even if prices move on the favourable side as the maximum loss for the options buyerbeing the extent of premium paid. Besides, as MCX now offers both options and futures in gold, with the former devolving in the latter on expiry, a wide array of effective hedging strategies can be created using combinations of futures and options. These combinations can give the hedger the leverage of futures with safety of options, a strategic benefit not available earlier. Above all, thanks to their low transaction cost and high hedging effectiveness, options provide better cash-flow management to hedgers.